Michael Shulman

5 Short-Side Investment Rules

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Not only is it possible to make big bucks on falling stocks, but savvy short-side investors do it all of the time.

Whether you're shorting a stock the traditional way or doing it the smart way -- which is to buy put options -- choosing a name to play to the downside should be just as well-thought-out as any long-side play that you add to your portfolio.

But how do you go about finding spectacular short-side plays and, more importantly, profiting from them? I have five solid rules that shed some light on how to survive and thrive on the "dark side."

First rule -- If we don't stand a chance of winning, then we don't play

The underlying stock must not have any predictable, potential upside catalysts on the horizon.

In 2008, we learned this with Palm (PALM), which our ChangeWave Alliance surveys showed was getting beaten with the ugly stick by smartphone manufacturer extraordinaire Research In Motion (RIMM), whose BlackBerry was living up to its "CrackBerry" moniker at that time.

Things were going our way, playing the short side of PALM, until a very surprising influx of private-investment capital arrived to save the day. Even though nobody in their right mind should have been buying PALM (the company or the stock), it's amazing how much impact a significant cash infusion can make on potential shareholders.

So, when our Alliance research showed that Sears' (SHLD) perception was sliding among customers, but with financier Eddie Lampert on the horizon -- the man who runs the hedge fund that owns Sears -- there was no way we were going to short a company with arguably $140 billion in real estate value on the balance sheet with Lampert at the helm.

Bottom line, a stock may be a fundamental disaster, but when cash flows into it, the smartest thing a short-side investor can do is to run, not walk, in the other direction.